Trade deals – a global issue

By Alasdair Macleod

Alasdair Macleod October 06, 2016

The annual Conservative Party conference commenced last Sunday, and the media focus was mostly about the Government’s stance on Brexit.

This is hardly surprising, because Mrs May is being secretive, avoiding stoking a public spat with the EU by negotiating in public. The only hard news to emerge was that Article 50, formally giving notice of Britain leaving the EU, would be triggered by the end of March, in other words before the end of this tax year.

Brexit is mostly about trade deals, which is why big business is lobbying furiously, and EU functionaries are winding up their punitive rhetoric. In the US, Donald Trump has also wound up the rhetoric over trade, threatening to tear up NAFTA and refuse to ratify the trans-Pacific partnership. He also attacked China, accusing her of stealing American production and jobs. We should never believe anything a politician says on the stump to gain votes, but if nothing else Trump does seem to have identified electoral resentment on the trade issue.

This article looks at the theory behind trade, and finds that free trade, not the promotion of vested interests, should be the clear economic objective. But it also concludes that differing approaches to this thorny subject could accentuate the split between world trade into two separate streams, between fast-growing emerging economies and an increasingly sluggish old order.

Corn laws and Smoot-Hawley

Free trade first became a political issue in Britain when the 1815 Importation Act, which imposed tariffs on imported grain, led to artificially high grain prices, benefiting landlords at the expense of the poor. This was repealed by the Importation Act 1846. These Acts were known as the corn law and its repeal respectively.

The debate prior to the 1815 Act is echoed today, with producers always seeking to disadvantage foreign competition to the detriment of the consumer. However, there’s every reason to believe that the abolition of trade barriers and tariffs would be similarly beneficial to contemporary economies as the Importation Act 1846 was to both Britain and the global economy then. Equally, if this is true, then trade restrictions and tariffs hinder economic progress, and any country embarking on greater trade restrictions is therefore pursuing a deliberate policy of unemployment. For evidence that it is indeed true, we need look no further than the catastrophic introduction of the Smoot-Hawley Act of 1930 in the US.

America’s success in the 1920s was ascribed by many contemporary politicians to earlier protectionist legislation, the Fordney-McCumber Tariff of 1922. Economists in those days, bearing in mind that this was pre-Keynesian times, took a very different view from the political class, that the twenties roared despite Fordney-McCumber, not because of it. When 1,028 economists wrote to President Hoover to veto Smoot-Hawley, he ignored the advice and signed it into law, it being consistent with his “high wages policy” for American workers. Economic historians today tend to downplay Smoot-Hawley, instead focussing on the market crash and Irving Fisher’s debt-deflation explanation of the collapse of some 9,000 banks. With hindsight, Keynesians such as JK Galbraith, attributed the depression to the Wall Street crash, the resulting collapse in investment spending and the collapse of consumer demand.

These were myopic mistakes, reflecting only part of the story. American protectionism provoked retaliation from her major trading partners, and American manufacturers found that tariffs on imported raw materials and semi-manufactured goods imposed by their own government made their goods unaffordable, putting them out of business. The consequence was a wave of industrial bankruptcies and a severe contraction of both domestic and international trade. The end result was that world trade is estimated to have contracted from $35.6bn to less than $12bn between 1929 and 1934.1

The effect on commodity prices was catastrophic. Instead of protecting American farmers, an important consideration for President Hoover, the collapse in grain prices in 1930-32 (which had already been falling throughout the twenties) brought great hardship to farmers not only in America, but around the world. Wheat, which had peaked at $2.45 per bushel in 1920, fell to a low of 49 cents in 1932. There can be little doubt that the imposition of trade restrictions through high tariffs under the Smoot-Hawley Act of 1930 played a large part in intensifying the Great Depression, driving down commodity prices, and bankrupting farmers, commercial enterprises and banks.

Trade theory today

The lessons of trade history and their credible explanations, from Britain’s corn laws to America’s Smoot-Hawley Act, are mostly ignored by today’s macroeconomists. Politicians instinctively attribute trade deficits to unfair foreign competition, when trade deficits are in reality the result of credit expansion, savings contraction, and government deficits. This is why Donald Trump’s ignorance over trade resonates with President Hoover’s appalling miscalculations in 1930. Politicians can only think about job protection based solely on an understanding of first-order effects, exhibiting mindless ignorance of further consequences.

Things are different today, in that there is a World Trade Organisation which lays down rules, most ignored by, surprise, surprise, America followed by the EU. This has led to a twin-track world, where America and the EU tend to permit international trade on a restricted basis, while emerging nations trade with each other relatively freely. There are no prizes for guessing which of these two categories is growing more rapidly than the other.

Another difference is that economics has moved from the classical to the neo-classical, which means that the expert advice given to politicians has also changed. Don’t expect 1,028 economists to write to President Trump (or Clinton) warning about the toxic effects of restricting trade, as they did to President Hoover. In the EU, the benefits of free trade are only recognised between member states, but how their trade DNA differs from the rest of the world is neither questioned nor explained. Out of all this confusion is stepping Britain, which through Brexit has voted to break ranks on trade.

Unfortunately, the British political class, with relatively few exceptions, appears as clueless as Donald Trump when it comes to trade policy. Politicians are more open to persuasion by lobbying corporations, primarily concerned with protecting their own markets and profit margins, than to economic reason. Political advisors and civil servants tend to be paid-up members of the Keynesian Club, thinking that all economic problems can be solved by demand management in the domestic economy by the promotion of consumer confidence.

The British position

With all the institutional biases of her office and exposed to industrial lobbying, Mrs May, the Prime Minister, will shortly be embarking on trade negotiations with the EU. For the moment, she is playing her cards close to her chest, and refuses to be drawn by both the press and her own back-benchers. This is sensible, if she is merely resisting lobbying pressure, and has a clear objective in mind.

This is quite possible, but we have no way of knowing, and must not forget that the majority of the British cabinet is staunchly establishment. Nevertheless, we can assume her two Brexit ministers are quietly feeling their way towards free, or relatively free trade agreements with the Commonwealth, China and a number of other candidates, who will welcome them with open arms.

This was partly confirmed by Liam Fox, the International Trade Secretary, who in his Conference speech confirmed that existing trade deals between other countries and the EU would be simply rolled over to the UK on Brexit day. New Zealand has even offered to lend Britain her own trade negotiators to help speed the process with other states. Under the World Trade Organisation’s most favoured nation rules, Britain would then have to offer similar deals to her other trade partners, including the EU, which seems to suggest that Britain can easily become a free trade area.

It will not be in the EU’s commercial interest to reject a free-trade proposal from the UK, because the other EU countries are net exporters to Britain. However, the EU could well decide to reject a British trade proposal on the purely political grounds that Brussels will want to discourage other member states from following Britain and deciding to leave the Union.

If this turns out to be the case, everything would not be lost, because Britain could easily reduce corporation tax to compensate UK-based multinationals and exporters for losses arising from the EU’s intransigence. With a combination of some key free trade agreements, which can be very quickly signed, and the tax weapon, Britain can effectively tell her EU partners to take it or leave it. This would be far more effective and practical than trying to negotiate a complex trade deal, which requires the political support of all 27 other EU states.

Critics of Brexit and lobbying companies also miss a vital point. The EU is a busted flush, and in all probability is sinking into a black hole of its own making. We all know that the banking system in Euroland is in deep trouble, but few people take to trouble to enquire further. The banks are just the messenger. The Italian, Spanish and French economies are in serious decline, not to mention Portugal and Greece. So you can fix the banks all you like, but you won’t fix the underlying problem.

As these truths become increasingly evident, British companies currently lobbying for access to EU markets will discover they have wasted their time. For this reason, a delay in triggering Article 50 until March next year could strengthen Britain’s negotiating position, due to the EU’s economic decline.

Two tracks in world trade

We must return to the theme of two contrasting approaches to world trade, with emerging nations trading more freely than the US and EU with their tariffs barriers. In the past, emerging nations suffered a substantial disadvantage, being denied access to American and European markets, often on spurious grounds. Their situation was similar to that of the post-WW1 nations, which having been impoverished by the war, were not in a position to retaliate against America’s Fordney-McCumber Tariff legislation of 1922.

The balance of power in trade today has shifted significantly, with emerging nations trading increasingly with each other, and becoming less dependent on trade with the US. Furthermore, with respect to both the EU and the US, the World Trade Organisation guarantees the bulk of tariffs imposed to be far less than the punitive rates under Smoot-Hawley.

China has multiple free trade agreements of its own, the most important of which are the ASEAN-China Free Trade Area, and the Shanghai Cooperation Organisation. There is little doubt that China and her free trade partners increasingly resent the American approach to trade, and are moving away from the American sphere of influence. Furthermore, the danger for both the US and the EU is their protectionist approach to trade is adversely affecting their own economic performance, probably more than they realise.

This won’t stop the US and the EU intensifying their autarky, the former regarding the rest of the world as existing only to do its bidding, and the latter bearing a grudge against any trade beyond its control. Inevitably, this introduces geopolitical factors into the subject. Being already on the back foot in her geopolitical strategy, Washington will not want to see the UK strike free trade deals with China, and possibly in due course, Russia. A principal concern is that trade with these emerging market partners will increasingly side-line the dollar, and promote the interests of its enemies, something the UK is already doing by encouraging yuan trading in London.

Behind the scenes, America seems certain to discourage Britain from pursuing the free trade route. Therefore, free-traders in the British government are up against an establishment susceptible to advice and threats from vested interests, including the EU, the US, and lobbying multinationals dominated by American interests. Neo-classical economists and the politicians they advise, with no way of assessing the counterfactual, will be generally unaware of the damage caused by this approach, and will not argue in favour of free trade.

The temptation will be to find some sort of compromise. But the real choice Britain faces is black or white: stay with the old, dying imperialistic model, or unite with the new, embracing free trade as a general economic benefit for all.

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